For a deeper understanding, let's take a look at the four determinants of demand:
- Consumer's incomes.
- Consumer's attitudes.
- Price of a complementary product.
- Price of a substitute product.
Understanding these four determinants will help you protect your business from unexpected changes in demand.
Imagine that you just won the lottery and went instantly from rags to riches. How will your spending behavior change? First, you will probably spend a lot more than you did previously, increasing your demand for almost every category of goods. Goods that you consume more as your income increases are called normal goods. For example, as you get richer, you will probably invest more in your education, take more vacations, etc. The converse is also true. As you get poorer, you will cut back spending on normal goods.
Let's continue on with our little daydream. How will your spending habits change? Most likely, you will cut back on your consumption of instant noodles and eat more stakes. Goods that you will consume less of as your income increases are called inferior goods. On the other hand, as your income decreases, your spending on inferior goods will increase (back to eating instant noodles).
Corporations and institutions spend billions every year trying to manipulate our attitudes toward their products (like how cool the iPod is) or other people's products (like how harmful smoking is). The reality is that much of our spending is based on our attitudes instead of the intrinsic value of our purchases.
Over time, tastes, sentiments, social values, culture, laws, etc. changes. These changes will change the demand for different products.
Price of a Complementary Product
First, what is a complementary product? Complementary products are products that are used together. For example, tennis balls and tennis rackets are complementary products as are hot dogs and hot dog buns.
Let's imagine that you own a gas station. What will happen to the demand for gas as the price for automobiles decrease, all else equal? You guessed it; demand for gas will increase as drivers fill up their new cars.
Price of Substitute Product
What is a substitute product? Substitute products are similar products that can easily replace each other, like margarine and butter. The idea is simple: demand for a product will decrease as the relative price of a substitute decreases and demand for a product will increase as the relative price of a substitute increases.